3 Pharma Stocks to Watch: Allergan, Valeant, and AbbVie

U.S. stocks yesterday reacted positively to the release of minutes from the Federal Open Market Committee's June meeting, but that is long forgotten this morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) down 0.74% and 0.78%, respectively, at 10:15 a.m. EDT. A greater than 1% loss today in the S&P 500 would break a 57-day streak without any daily moves of that scope -- the longest such streak since 1995! The pharmaceutical sector, which has witnessed frenetic deal activity this year, is on investors' radar this morning, thanks to information that broke late yesterday regarding two potential deals: Valeant Pharmaceuticals' (NYSE: VRX  ) $53 billion hostile bid for Botox maker Allergan (NYSE: AGN.DL  ) and AbbVie's $51 billion bid for Ireland-based Shire.

Source: Wikipedia.

First, in interviews with the Financial Times and The Wall Street Journal, Allergan Chairman and CEO David Pyott said some shareholders have prodded the company to consider a significant acquisition of its own, even as it wrestles with Valeant Pharmaceuticals' offer.

Valeant's business model is focused on acquiring pharmaceutical companies and paring costs, notably in the research and development function. Investors have cheered that strategy so far, sending Valeant's shares up nearly ninefold over the past five years. Meanwhile, Allergan has been telling its shareholders that Valeant's acquisition-driven model is unsustainable, that its organic growth is essentially zero, and that dramatically reducing R&D would cripple future growth prospects. These arguments are relevant to a long-term investor's decision process, as less than half of Valeant's offer is in cash, with the remaining portion in Valeant shares.

Nevertheless, Pyott has not remained totally immune to Valeant's logic, telling the FT that Allergan will halt some early stage development programs in order to reduce its R&D budget.

Pyott refrained from identifying any specific potential acquisition targets, but analysts' recent speculation have centered on Shire, which is already the object of AbbVie's attention. The bottom line is this: investors who have urged Pyott to consider an acquisition are right. The sector is undergoing another wave of consolidation, and by striking now Allergan has a chance of remaining independent and proceeding on its own terms. As far as Valeant's offer is concerned, I think long-term investors ought to set a high bar -- the risks Allergan has identified are legitimate.

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Alex Dumortier

Alex Dumortier covers daily market activity from a contrarian, value-oriented perspective. He has been writing for the Motley Fool since 2006.

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Related Tickers

9/2/2015 3:07 PM
^DJI $16260.58 Up +202.23 +1.26%
AGN.DL $0.00 Down +0.00 +0.00%
Allergan, Inc. CAPS Rating: ****
VRX $230.06 Up +6.01 +2.68%
Valeant Pharmaceut… CAPS Rating: ***